Impact of foreign direct investment, official development assistance and institutional quality on environmental degradation in developing countries

Developing countries have insufficient financial resources, which has hampered their pursuit of sustainable growth. As a result, these countries depend on foreign capital to fill the financial gaps, emphasising the role of foreign direct investment (FDI) and official development assistance (ODA) in their economic development. The influx of foreign capital raises concerns about these variables on environmental degradation in developing countries. This is because developing countries face serious environmental challenges, as most of these countries are in transition stages where production activities and energy consumption exponentially increase, and access to cleaner environments and investment in environmental pollution abatement strategies are deemed complicated. However, recent literature suggests that institutions play a significant role in preserving the quality of the environment, and many studies support the importance of institutional quality to promote FDI and ODA. Therefore, this study investigates the impact of FDI, ODA, and institutional quality on environmental degradation in 78 developing countries for the period of 2000–2018. On the first objective, the study examines the role of institutions in the FDI and environmental degradation relationships using the generalised method of moments (GMM). Results indicate that there is a positive relationship between FDI inflow and environmental degradation in developing countries when the whole sample is considered. However, a deeper investigation into the country’s income group suggests that there is a significant positive relationship between FDI and environmental degradation in middle-income countries. Interestingly, the magnitude of the impact reduces as the quality of institutions increases in these countries. On the second objective, the issue of environmental degradation in developing countries is examined from the perspective of ODA. Using the GMM, the results show that ODA significantly reduces environmental degradation. Therefore, we recommend that policymakers, especially in the lower-middle-income and low-income countries, concentrate on improving the quality of institutions since it significantly determines the environmental impact of FDI and ODA, respectively. FDI in the form of technological transfer should be encouraged in order to stimulate environmentally sustainable practises in economic activities. In addition, since energy consumption is significant, these countries must also consider implementing energy-efficient strategies to mitigate the environmental impact of energy consumption.

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